Commentary Type

American Eyes on Australia's Carbon Tax

Op-ed in the Australian Financial Review


Australia’s proposed carbon tax is attracting interest in some unlikely quarters of the American political landscape. Conventional wisdom in Washington is that the economic crisis coupled with the Republican takeover of the House of Representatives has killed the prospect of serious US climate change policy. Yet while American politicians don’t seem too concerned about rising global temperatures, they are definitely concerned about rising fiscal deficits. And the revenue raising potential of a carbon tax may become increasingly attractive in Washington in the years ahead.

A carbon tax has long been the favorite tool among economists for reducing greenhouse gas emissions. Imposing a tax on something that reduces welfare (like pollution) can allow policymakers to reduce taxes on things that increase welfare (like employment, investment or innovation). And it’s not just liberal economists that find a carbon tax attractive. Gregory Mankiw, Chairman of the Council of Economic Advisors under George W. Bush and Douglas Holtz-Eakin, senior economic advisor to Senator John McCain during the 2008 Presidential Campaign, have both argued the merits of taxing carbon and using the revenue to cut economically distorting corporate and payroll taxes.

It's the deficit reduction potential of a carbon tax that could give US climate policy a new lease on life.

This economic logic has elicited support from some leading Republican politicians as well. Most notable is Senator Lisa Murkowski of Alaska (the highest ranking Senate Republican on energy policy issues) who, while opposing efforts by the Environmental Protection Agency to regulate greenhouse gas emissions, has publically supported a carbon tax. She is joined by ExxonMobil chief executive Rex Tillerson, who argues the economic certainty that comes with a carbon tax is more important than the environmental certainty you get with cap-and-trade.

And for Americans increasingly concerned with the security of the country’s energy supply, a carbon tax could yield some unexpected benefits. A colleague and I recently analyzed all leading energy security proposals currently bouncing around Washington—from vehicle efficiency standards to expanded offshore oil drilling. And we threw a carbon tax in just for fun. To our surprise the carbon tax did more to reduce US dependence on foreign oil than almost any other proposal because it both reduced oil demand and increased domestic supply. The latter occurs thanks to a) an increase in natural gas liquids production, an oil substitute pumped alongside the natural gas used to replace coal-fired power plants, and b) CO2 captured from remaining coal-fired power plants used to coax more oil out of older domestic wells.

Yet the economic or energy security merits alone aren’t enough to win most American politicians over, and in the current political environment the global climate benefits don’t help much either. It’s the deficit reduction potential of a carbon tax that could give US climate policy a new lease on life.

For a recent fiscal solutions summit in Washington, six leading American think tanks put forward plans for cutting the US budget deficit. Four of the six suggested pricing carbon as a way to raise government revenue, including the conservative American Enterprise Institute (AEI), which recommended a carbon tax starting at $20 per ton and growing by over 5 percent per year after that. The AEI proposal would raise $161 billion per year by 2020, enough to reduce the federal budget deficit by 22 percent that year. That’s greater than the savings Washington would get from raising the national retirement age to 70 and equivalent to eliminating all foreign aid and federal funding for education.

As a source of revenue, a carbon tax is not without its downsides. Poorer Americans and rural Americans both spend more on energy than the national average and thus would bear a disproportionate burden. A significant share of the revenue raised from a carbon tax would need to be used to offset these distributional inequalities. And the newly elected Congressional Republicans came to Washington with a mandate to reduce the deficit through spending cuts alone so taxes of any kind are likely off the table during this political cycle regardless of their distributional impact.

But as voters start feeling the effects of those spending cuts in the years ahead, tax increases may well enter the picture. If that happens, a carbon tax could look pretty good on paper compared to the alternatives, and America will turn to Australia to see how it looks in practice.

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